Dudley Says Decision on Taper Will Require 3-4 Months

William C. Dudley, president and chief executive officer of the Federal Reserve Bank of New York, speaks to the Japan Society in New York, U.S., on Tuesday, May 21, 2013. Photographer: Scott Eells/Bloomberg

May 22 (Bloomberg) -- Federal Reserve Bank of New York
President William C. Dudley said policy makers will know in
three to four months whether the economy is healthy enough to
overcome federal budget cuts and allow the central bank to begin
reducing record stimulus.

“I don’t really understand very well how the tug-of-war
between the fiscal drag and the improving economy are going to
sort of work their way out,” Dudley said in an interview with
Michael McKee airing today on Bloomberg Television. “Three or
four months from now I think you’re going to have a much better
sense of, is the economy healthy enough to overcome the fiscal
drag or not.”

Dudley’s remarks underscore that Fed officials have yet to
reach consensus on when or how to dial back their $85 billion
monthly bond-purchase program designed to spur growth and lower
unemployment. Philadelphia Fed President Charles Plosser has
called for reducing stimulus at the Fed’s next meeting in June,
while St. Louis’s James Bullard said yesterday the purchases
should continue.

“If we continue to do purchases, we’re adding stimulus,”
Dudley said. “People act like if we dial the rate of purchases
down, somehow we’re tightening monetary policy. What we’re
actually doing is adding less stimulus.”

Permanent Vote

Asked if the Federal Open Market Committee has agreed upon
a strategy to taper purchases, Dudley said, “we haven’t gotten
to that point.” Dudley, 60, is vice chairman of the panel and
has a permanent vote, unlike other regional Fed bank presidents,
who rotate.

Federal Reserve Chairman Ben S. Bernanke told the Joint
Economic Committee of Congress today that the economy remains
hampered by high unemployment and government spending cuts, and
raising interest rates or reducing asset purchases too soon
would endanger the recovery.

“A premature tightening of monetary policy could lead
interest rates to rise temporarily but would also carry a
substantial risk of slowing or ending the economic recovery and
causing inflation to fall further,” Bernanke said. Monetary
policy is providing “significant benefits,” he said.

Dudley said improvements in the economy may be obscured by
a combination of tax increases and automatic federal spending
cuts, known as sequestration, which are curbing growth. He
estimated this “fiscal drag” at 1.75 percent of gross domestic
product this year.

Beneath Surface

“The important thing to recognize about the U.S. economy
is that things are actually improving underneath the surface,”
Dudley said in the interview. “We don’t really see that so much
in the activity data yet because of the large amount of fiscal
drag.”

More Americans than projected filed first-time claims for
jobless benefits in the week ended May 11, and industrial
production declined in April by the most in eight months, signs
that budget cuts may be rippling through the economy.

At the same time, Fed stimulus has helped propel U.S.
stocks to successive records and pushed home prices higher. That
has helped boost household balance sheets and consumer
confidence.

“Because the outlook is uncertain, I cannot be sure which
way -- up or down -- the next change will be,” Dudley said of
the Fed’s bond purchases in remarks yesterday to the Japan
Society in New York.

In the interview, Dudley said the goal of Fed policy is
“really about achieving escape velocity. When are we going to
have an economy where everything is sort of self-reinforcing,
and when the jobs generate income, the income generates demand,
demand generates more employment?”

“I don’t think we’re quite there yet,” he added.

Once a decision is made to begin withdrawing stimulus, “we
certainly want to do it in a way that it’s not abrupt, it’s not
shocking,” he said. “We want to make sure that the markets
don’t overreact to our first move in terms of dialing down the
rate of asset purchases, or later on actually starting to raise
short-term interest rates.”

Exit Strategy

Dudley said the Fed is “revisiting” the exit strategy
that it drew up in June 2011 as it sought to assure investors
that it had the means to avoid igniting inflation once job
growth, wages, and demand started moving up. The plan was part
of Bernanke’s push for greater transparency and predictability.

He said the withdrawal principles “look a little bit out
of date to us.”

That strategy calls for the Fed to allow assets to mature
without being replaced. The central bank would then modify its
guidance on how long it plans to keep the federal funds rate
near zero and begin temporary operations to drain excess bank
reserves. The Fed would next raise the federal funds rate, and
finally, start selling securities.

Dudley said the Fed had the ability to “manage monetary
policy effectively even with a very, very large balance sheet, a
balance sheet even bigger than the balance sheet that we have
today” and therefore “we don’t necessarily have to sell off
assets.”

Dudley was a Goldman Sachs Group Inc. economist before
joining the New York Fed in 2007. He became president of the
regional bank in 2009, succeeding Timothy F. Geithner.

‘In Sync’

Asked if there was much difference between his views on
monetary policy and Bernanke’s, Dudley said the two were “very
much in sync.”

“We do have our debates, but at the end of the day, we
usually get to the exact same place,” he said. He said he had
“no idea” whether the Fed will have a new chairman when
Bernanke’s second four-year term expires in January.

Dudley said he would “absolutely” support Vice Chairman
Janet Yellen for the top job.

“I have tremendous respect for her ability,” he said.
“She is bright. She is tough. She is determined. She’s brave.
These are all the qualities that I think a Fed chairman should
have.”